What interest rate risk policy limits have other banks set?

Back in December I completed a series of posts about setting ALCO policy limits for interest rate risk. One of the questions we often get asked is, what policy limits do you see at other banks? We have some data that will help answer that question. Each quarter for the past 3 years we’ve been asking our A/L BENCHMARKS clients, and canary report users to answer and update a survey of their IRR policy limits.

The first question we asked was: What is your bank’s Net Interest Earnings at risk policy limit given +/-200bp shock? The largest response is in the “-5.1 to -10.0” category. 24% of those responding choose this range and based on my experience I’m guessing that most of them have a limit of –10. I was a little surprised to see the size of responses to the “15.1 to 20.0” category. Again I’m guessing that most of these responses mean –20.0 rather than something in between. A -15.0 to –20.0 net interest earnings at risk is relatively high, but not extremely high. And if a bank is growing, a –15.0 net interest earnings at risk limit or above is reasonable.

The second question we asked was: What is your bank’s EVE at risk policy limit given +/-200bp shock? The largest response here was in the “Unknown or No Limit” category. I could get really cynical here and say that I’m not surprised. Most bankers really don’t pay that much attention to the EVE measurement anyway…but maybe I’ll save that for another post.

Beyond the “I don’t know” or “No limit” category, one of the largest responses is -15.1 to -20.0. This seems quite normal because the rule-of-thumb is usually -20.0. Again I was bit surprised by the volume of responses in the –5.1 to –10.0 category, especially for EVE at risk. Equity, almost by definition, is a levered position. Total equity to assets for community banks can be as low as 7%. When you measure changes in total balance sheet value against the comparatively smaller amount of equity you tend to see much more volatility. In general EVE at risk tends to be higher (i.e. more volatile) than net interest earnings at risk. I think an EVE at risk limit of –10.0 or less is pretty tight. Bank’s with generally shorter-term assets can probably manage to a tight EVE at risk limit like that; but banks with longer-term assets would probably have a harder time.